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December 24, 2012

As the Year Turns, Time to Go Back to Stocks?

With the stellar performance of bonds over the past decade and cash returning close to zero, where can you find alpha? To the point, is it safe to resume a higher allocation in stocks?

I have a chart in my office that displays the gain needed to break even after a loss in a specific investment or an overall portfolio. For instance, if you lose 10%, you'd need to earn 11% to break even. A 50% loss would require a gain of 100% to get back to even. In other words, it illustrates that as losses increase in increments of 5%, the gains needed to get back to even increase exponentially. The moral is clear: Avoid large losses.

The great economic boom of the 1980s and 90s was fueled in large part by a great amount of leverage. Debt increased at an alarming rate during this period, but of course, there were few alarms sounding. Then, when the end came, when the bubble burst, it was clear that a prolonged period of deleveraging would ensue. But how long will this period last? And with less debt as a catalyst, growth will be considerably slower than it was during the expansion.

Today, the most disconcerting issue to me is the reckless fiscal path on which we are traveling. America is amassing debt at an alarming rate. In short, we will look like Greece if something doesn't change. Moreover, with the Fed functioning as the chief supplier of capital, there is theoretically no limit to the amount of debt we can amass. Of course, unabated money printing does have its consequences. As the Fed's balance sheet continues to expand, at some point, this easy money policy could well blow up in our face, causing interest rates and inflation to spike. This is a scenario which does not end well.

Themes to Consider

With all of the issues surrounding America's fiscal policy, I do see some positives.

Globally, the economy was, and possibly still is, slowing. As I mentioned several months ago, emerging market bonds should continue to do well as their central banks reduce rates. Also, it appears real estate has bottomed and a good quality real estate fund may be warranted.

I've been investing in real estate since 2009, but I think there's still room to run. Here are a couple of my favorite funds in these asset classes. Fidelity Advisor Emerging Markets Income (FMKIX) and Nuveen Real Estate Securities (FARCX). You might also consider Non-Traditional bond funds. In this space, I like the Western Asset Total Return Unconstrained (WAARX).

To conclude, I'd like to say thanks for reading and I wish you all a Merry Christmas and a prosperous 2013!